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MLP Distributions: Turning CAGRs into Dollars

Now that MLP distribution season has come and gone, it seems like a good time to check which MLPs have been growing distributions faster than others, and what (if anything) that might tell us about past performance and future results.

First, a couple of parameters: in my analysis of distribution CAGRs, I looked back three years and calculated annual distribution growth rates over those three years. Therefore, I didn’t include any MLPs that have not been public long enough to have paid distributions for the last three years. Also, I did not include the pure play MLP general partner holding companies.

A summary of the data on the 52 MLPs in my sample is in the chart below. In summary, the 10 MLPs that have grown distributions fastest have on average increased distributions 11.3% annually over 3 years and 17.4% year over year. Those 10 MLPs well outperformed the overall average total returns of the MLPs in my analysis in 2011 and 2010, but have lagged to date in 2012.

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It is surprising to see how well the slowest growing MLPs have performed so far in 2012. It appears that investors are reaching for value after the market has already priced in the rapid distribution growth of the top 10, and so the slow growth MLPs are getting a second look.

Perhaps the most interesting data point is how poorly the middle of the pack distribution-growing MLPs have performed, finishing with total returns well under both the fastest and slowest growth MLPs, despite 3.4% average annual distribution growth the last 3 years. It is interesting to see that the middle 10 grew distributions the last 4 quarters at a pace slower than the top and bottom distribution growth MLPs.

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I am in the business of actively managing MLP portfolios. I try to balance my desire to pick the MLPs that will have sector-leading returns without taking on the risk and volatility that usually accompanies the highest flying MLPs. When I evaluate MLPs, I look closely at CAGRs, but taken in a vacuum like this, they don’t mean much. To really have an actionable data set, you need to include current valuation and distribution coverage. You want to buy MLPs that are trading at low distributable cash flow multiples with high distribution growth prospects. Call it growth and coverage at a reasonable price (or GACARP as opposed to the traditional GARP).

In the chart below, you can see further details and breakdowns of the numbers I ran. El Paso Pipeline Partners (EPB) has grown its distribution at an annual rate of 16.0%, the fastest of all MLPs (obviously not including general partners). EPB’s distribution growth has resulted mostly from drop-down acquisitions from parent El Paso. Second on the list is another drop-down MLP: WES.

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Looking at this chart, what sticks out is how well the slow- and in some cases no-growth MLPs have done. Take Cheniere Energy Partners, L.P. (CQP), for example. CQP has never increased its distribution, and in fact when it initially went public used IPO proceeds to pay distributions, which is sketchy by any standard. And yet, without ever increasing its distribution, CQP has provided investors with the 2nd highest total return of all MLPs since the beginning of 2009 with 615%, second only to Markwest Energy Partners (MWE) with 751%. CQP’s comeback and success are a result of growing optimism of the potential for LNG exports and solid execution of the company’s export project plan.

Other MLPs that have fared well despite no growth are Eagle Rock Energy (EROC), Copano Energy (CPNO) and EV Energy Partners (EVEP). EROC is still dragging itself out of the whole it dug (then threw itself into) in 2008, and with each checkpoint along the way, the market has rewarded EROC investors. CPNO has benefited from its geographic position and execution of projects in and around the Eagle Ford Shale. EVEP has benefited from the speculation and early results of drilling in the Utica shale.

Like any investment, what matters is simple: the entry, the exit and what the investment pays while you own it. In traditional non-MLP investment (stocks), you can buy companies that consistently grow earnings and dividends, but there are times when you can purchase stocks at an elevated relative price, and even with high growth, there might be other stocks in that particular industry that will offer better investment returns, because the higher growth stocks were priced too high. In MLPs, as in stocks, as in life, timing is everything.

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